Mar 28, 2016

24 Hour Personal Finance Course: What's Your Risk Profile? (Investing)

On Friday, I had a 45 minute lesson at Eastside Prep. with my main learning objective to help the students understand their risk profile and how that impacts their approach to investing (for more on helping students understand risk, listen to my recent podcast with NY Times columnist Ron Lieber)

  • We started with a PollEverywhere with the students creating a word cloud on what words came to mind when they think about risk:

Screen Shot 2016-03-25 at 12.36.06 PM

  • A class discussion ensued in which we discussed how we often associate negative terms (trouble, caution, fear, lost, losing money, loss) with risk. I transitioned the conversation to the importance of risk when it comes to investing and introduced the concept of return (or how much profit you earn from an investment).
  • I asked the students to write down what they thought their risk profile was. I realize that none of them had invested before but I wanted them to think about decisions they were making in their life today and whether they could characterize themselves as risk seeking or cautious or somewhere in between.
  • The students then played two interactives that measured their risk profile to see if they matched their self-concept:
    • Risk quiz: short quiz that provides them with a risk score)
    • Balloon Test: a game that involves a student pumping up a balloon that can burst at any time. The game ends after the balloon bursts five times and a player is shown how their pumps (risk) and points (return) compare to others playing the game. Students played the game several times and jotted down their pumps and points for each game.
  • Students were then asked how their self-assessment of their risk profile matched the outcomes from the quiz and the balloon test.
    • One student commented that initially she was very tentative in playing the balloon test but got more comfortable over time and was willing to take more risks as the game progressed. That was a great segue to discuss how students might be very uncomfortable with investing in the stock market because of the risk of loss but will get more comfortable over time.
  • Next, we transitioned to discuss the relationship between risk and return (or profit that one could expect from an investment). I drew the X and Y axis of this chart and asked students to draw a line that they thought represented the relationship between risk and return.

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  • Then I asked them to plot four different investments on the line (after discussing the risks inherent in each of them):
    • Start-ups:  highlighted that most start-ups fail but others become $200 billion + businesses (Facebook)
    • Stocks (like S&P500 index)
    • Bonds: distinguished between Treasury bonds and Corporate bonds
    • Savings accounts: opportunity to discuss FDIC and $250,000 guarantee if banks fail

It is important for them to understand that just because start-ups are in the upper right of this chart doesn’t guarantee that they will generate higher returns since most start-ups fail. There is a reason the word “potential” is sandwiched between “high” and “return.”

  • I then pressed a few students to tell me based on what they know about themselves and the relationship between risk and return, how they would think about splitting up their investments between stocks and bonds aka asset allocation. I got answers ranging from 80% stocks /20% bonds to 50% stocks/50% bonds.
  • Using this calculator (use starting principal as $1), they were then able to see how these asset allocation decisions (and I used their 401(k) as the investment vehicle) would impact what they might accumulate over their working life (40 years).
    • I used the following inputs for expected returns for stocks (8%), bonds (3%) and savings (1%).
    • I used a few examples to show them the impact of:
      • 100% stock portfolio
      • 75% stock/25% bond
      • 50% stock/50% bond
  • Closed the class with the question, “Since stocks generate the highest return, why not put 100% into stocks? Answers varied from:
    • May be hard for me to deal with the ups and downs
    • Importance of diversification
    • Scared of stocks
      • This provided a good opportunity to return to the Balloon test and describe how many students got more comfortable over time and how by “dipping their toe” into stocks they too can get more comfortable over time.
 

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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